Investors identified sovereign risk as the main challenge facing the covered bond market this year in response to a Fitch survey, which also found increased appetite for covered bonds.

One hundred investors participated in the survey, which was conducted in December, with 13% of the accounts managing more than Eu20bn in covered bonds, 25% managing between Eu5bn and Eu20bn, and 62% having less than Eu5bn in their portfolios.

The number of investors who put sovereign risk as their top concern, at 59%, was up from 37% a year earlier. The health of the banking sector was the second main concern, at 21%, and underlying collateral performance was selected as their top concern by 9% of investors, down from 21% last year.

Of the respondents, 88% planned to increase their current holdings of covered bonds or maintain them within the next 12 months, up from 83% in December 2010. Ten percent expected to increase their holdings significantly, and 1% said they intended to reduce them significantly.

Fitch noted that some countries were preferred as investment opportunities, and that investors were likely to decrease their exposure to peripheral countries.

“Our survey shows that investors have a growing appetite for covered bonds, but are selective in what they buy,” said Beatrice Mezza, senior director for business and relationship management at Fitch. “They expect to increase exposure to Scandinavia, Australia, UK and the Netherlands, which is where most of the supply has come from in the first weeks of 2012.”

Only 10% of respondents said they are only comfortable with pools exposed to AAA countries, while 24% said they are not buying public sector covered bonds exposed to peripheral European countries, and 57% are making investment decisions on a case by case basis.

Non-AAA covered bonds could be bought by 83% of the study participants. Investors’ rating limits were evenly split between AA, A, BBB, and no limit at all.

Flexibility with regard to structure was also shown in the study, with 71% of investors prepared to buy covered bonds with soft bullet maturities, compared with 62% in 2010. The percentage of participants that would only buy hard bullet covered bonds has decreased from 34% to 29%.

The survey also showed that while new countries are planning to introduce covered bond legislation in 2012, 52% of investors are active buyers of contractual programmes, with 29% of this majority requiring a higher spread than for regulated covered bonds. Some 35% were comfortable buying covered bonds secured by assets other than mortgages or public sector loans, and required a higher spread to do so.

Fitch added that when asked to list in order of priority which research investors use when monitoring their covered bond holdings, “investors said they consider rating agency credit analysis and performance reports the most relevant, followed by the issuers’ own web sites and investment banks’ credit research”.

The majority, at 68%, of investors required at least two rating agencies to feel comfortable buying a covered bond and 26% would buy a bond with one rating.